Tax and your investments

Saving is the new trend so this briefing outlines the key characteristics of alternative investments for individuals. In particular, as nothing rankles more than being taxed on savings which have already been taxed as earnings, the main focus will distinguish the relevant income and capital taxation implications of each type of investment.

Investment planning

Any individual seeking to make investments needs a plan. To formulate an effective plan a number of personal factors need to be considered, as well as the characteristics of different types of investments. Personal factors will include matters such as your age and stage of life, attitude to risk, required investment period, income or capital needs, taxation position and the need for ready access to cash.

For example, John, who has just retired at 65 with a lump sum, is likely to be influenced by different factors compared to Helen, who has inherited some funds and has just started her first job after University.

Interest based products

Interest based products are frequently a component part of an individuals investment portfolio. They include bank and building society accounts, government stock, company debentures, loans and bonds and National Savings and Investment bank (NS & I) products such as savings certificates.

Tax characteristics

Interest is generally taxable although there are some tax free interest products. These include interest on an Individual Savings Account (ISA), various products from NS & I and certain provisions for children.

Some taxable interest is paid to the individual in full without deducting tax at source. Key examples include interest on most government loan stock and certain NS & I products. This is useful where the recipient is not a taxpayer as it avoids the need to claim a tax refund, but for taxpayers it means they will have to account for the right tax to HMRC.

Most taxable interest received by an individual has 20% tax deducted already, so a basic rate taxpayer has no further tax to pay. For a higher rate taxpayer there is an additional 20% still to pay.

However, for some individuals such as children, students, non working adults and pensioners a tax refund may be due which has to be claimed from HMRC.

Comment

Some taxpayers may not be liable for any tax or liable for only 10% tax on interest received. Where tax of 20% has been deducted already, a repayment claim will be necessary to recover the tax. Where no tax liability is anticipated for the tax year you can instruct the bank/building society not to deduct tax at source by completion of a form R85.

Equity based products

Investing in company shares can be used for both income return and capital growth depending on how the investment is structured. The available choices are significant, ranging from direct investment in the shares of a single unquoted trading company, to owning units in a fund which has a worldwide portfolio of shares in listed companies.

Income tax treatment

The income from shares referred to as a dividend is generally taxable. It is either chargeable on an individual @ 10% or 32.5%. For basic rate taxpayers there is no actual tax to account for because all recipients are given a tax credit, which is used solely for the purpose of cancelling out the 10% tax charge. No refunds are possible for non taxpayers. For higher rate taxpayers they have to settle the additional tax.

Capital gains tax (CGT) treatment

Any increase in the value of shares or share based products is generally chargeable to CGT on disposal. In certain situations a relief may be available to reduce or even defer a gain. Individuals also have an annual CGT exemption which currently stands at 10,100 to exempt their gains with any excess then chargeable @ 18%.

Comment

CGT reliefs are mainly available on business shares - an example is Entrepreneurs Relief which requires that an individual has both a minimum 5% shareholding and is either an employee or officer of the relevant trading company in the 12 months up to a disposal. So, where the individual is not involved in the company, other than as a shareholder, this particular relief would not be available to reduce the chargeable gain.

Where losses on equity investments arise, these can only generally be relieved against other gains. However, there may be scope to relieve a capital loss against total income where the loss has arisen from an original investment in new unquoted trading company shares.

Buy to let property investments

The UK property market, whilst cyclical, has proved over the long-term to be a very successful investment. This resulted in a massive expansion in the buy to let sector in recent years.

For many investors buy to let involves acquiring property with the expectation of capital growth with the rental income from tenants covering the mortgage costs and any outgoings.

However, the gross return from buy to let properties - meaning the rent received less costs such as letting fees, maintenance, service charges and insurance - is no longer as attractive as it once was. Investors also need to take a view on the likelihood of capital appreciation exceeding inflation. Investors should take a long-term view and choose properties with care.

Which property?

Investing in a buy to let property is not the same as buying your own home. You may wish to get an agent to advise you of the local market for rented property. An agent will also be able to advise you of the standard of decoration and furnishings which are expected to enable a quick let.

Letting property can be very time consuming and inconvenient. Tenants will expect a quick solution if the central heating breaks down over the bank holiday weekend! Do not cut corners - a correctly drawn up tenancy agreement will ensure the legal position is clear.

Tax position

Income tax (IT) is generally payable on the rent receivable after deducting allowable expenses. Allowable expenses include mortgage interest, repairs, agents letting fees and an allowance for any furnishings provided.

The eventual disposal of a buy to let property is chargeable to CGT on the difference between the proceeds and any capital costs incurred. As with share disposals, where a gain arises any excess is charged at 18% after the annual exemption is used.

Tax efficient savings options

Individual Savings Accounts (ISAs)

ISAs are free of IT and CGT. There are maximum investment limits which apply for each tax year but no lifetime limits so over several years, large investments can be built up.

The ISA can be in stocks and shares or cash.

Individual Savings Accounts

2009/10

Overall investment limit

7,200

comprising

- cash up to

3,600

max.

- balance in stocks and shares

Overall

7,200

max.

Increase in limits

From 6 October 2009 the ISA limits for people aged 50 and over will be raised to 10,200, of which 5,100 can be held in cash.

The current ISA limits will be increased for all investors to the same amount from 6 April 2010.

Single Premium Investment bonds

This type of investment involves placing a lump sum into an insurance company fund which is invested over a number of years. It allows for the provision of tax efficient income for the duration of the plan. Withdrawals from the bond are tax free for basic rate payers and higher rate taxpayers can defer the charge to higher rate tax or even avoid it in certain circumstances. There is also normally no CGT liability on the maturity of the policy.

The Enterprise Investment Scheme (EIS)

EIS was introduced to encourage direct investment in unquoted trading companies. Each investment is generally a speculative equity investment in a single company over at least a three year period. Such investments are generally considered to be higher risk and so there are a number of attractive tax incentives available for the individual.

Income tax relief at 20% is available on new equity investment (in qualifying unquoted trading companies) of up to 500,000 in 2009/10. The relief can be used against the current periods tax liability or carried back for relief.

Gains on share disposals will be exempt if EIS shares are held for at least three years.

Losses on EIS share disposals are generally allowable against income or gains.

Where disposals of other types of chargeable assets (eg quoted shares, second homes, etc) are made, the gain can be deferred, where proceeds are reinvested in EIS shares.

Comment

This scheme is most suitable for those individuals who have a significant sum to invest. It can also accommodate those who may seek to offer commercial expertise to a qualifying unquoted trading company. Investment aims are capital growth over a medium to long-term period.

It is also clearly of interest for trading companies seeking external finance for development, but detailed rules must be observed so please contact us if this is of interest to you.

Venture Capital Trusts (VCTs)

VCTs were introduced on the back of EIS to encourage indirect investment in unquoted trading companies. A VCT is essentially a quoted company which is required to invest at least 70% in a portfolio of qualifying unquoted trading companies.

An individual investor in the shares of a VCT will be exempt from tax on dividends and on any capital gain arising from disposal of the shares in the VCT. Income tax relief currently at 30% is available on subscriptions for VCT shares, up to 200,000 per tax year, so long as the shares are held for at